Money and Finance
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Related books:
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Nudge: Improving Decisions About Health, Wealth, and Happiness
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Predictably Irrational: The Hidden Forces That Shape Our Decisions (Also available in an AUDIO BOOK)
- Links
Jeremy Grantham's Favorite Book (LINK) Related book: The End of Normal: The Great Crisis and the Future of GrowthDeal Tips From Buffett and Berkshire’s Other Managers (LINK) Related book: Berkshire Beyond Buffett: The Enduring Value of...
- Bridgewater On The Fed's Dilemma
Via Zero Hedge: In the old days central banks moved interest rates to run monetary policy. By watching the flows, we could see how lowering interest rates stimulated the economy by 1) reducing debt service burdens which improved cash flows and spending,...
- Why Placebos Work Wonders
Found via @farnamstreet. Say "placebo effect" and most people think of the boost they may get from a sugar pill simply because they believe it will work. But more and more research suggests there is more than a fleeting boost to be gained from placebos....
- Comparing Wealth Effects: The Stock Market Versus The Housing Market - By Karl E. Case, John M. Quigley, And Robert J. Shiller (2005)
ConclusionThe importance of housing market wealth and financial wealth in affecting consumption is an empirical matter. We have examined this wealth effect with two panels of cross-sectional time-series data that are more comprehensive than any applied...
- Resisting Influence - Philip Zimbardo And Cindy X. Wang
In The Lucifer Effect, we examined how social situations lead ordinary people to commit unimaginable acts of violence, discrimination, and indifference to the suffering of others. Many of us hope that if we were placed in such situations, we would be...
Money and Finance
The endowment effect: It’s mine, I tell you
Mankind’s inner chimpanzee refuses to let go. This matters to everything from economics to law
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“I AM the most offensively possessive man on earth. I do something to things. Let me pick up an ashtray from a dime-store counter, pay for it and put it in my pocket—and it becomes a special kind of ashtray, unlike any on earth, because it’s mine.” What was true of Wynand, one of the main characters in Ayn Rand’s novel “The Fountainhead”, may be true of everyone. From basketball tickets to waterfowl-hunting rights to classic albums, once someone owns something, he places a higher value on it than he did when he acquired it—an observation first called “the endowment effect” about 28 years ago by Richard Thaler, who these days works at the University of Chicago.
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The endowment effect was controversial for years. The idea that a squishy, irrational bit of human behaviour could affect the cold, clean and rational world of markets was a challenge to neoclassical economists. Their assumption had always been that individuals act to maximise their welfare (the defining characteristic of economic man, or Homo economicus). The value someone puts on something should not, therefore, depend on whether he actually owns it. But the endowment effect has been seen in hundreds of experiments, the most famous of which found that students were surprisingly reluctant to trade a coffee mug they had been given for a bar of chocolate, even though they did not prefer coffee mugs to chocolate when given a straight choice between the two.
The endowment effect was controversial for years. The idea that a squishy, irrational bit of human behaviour could affect the cold, clean and rational world of markets was a challenge to neoclassical economists. Their assumption had always been that individuals act to maximise their welfare (the defining characteristic of economic man, or Homo economicus). The value someone puts on something should not, therefore, depend on whether he actually owns it. But the endowment effect has been seen in hundreds of experiments, the most famous of which found that students were surprisingly reluctant to trade a coffee mug they had been given for a bar of chocolate, even though they did not prefer coffee mugs to chocolate when given a straight choice between the two.
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Moreover, it is now possible to see the effect in the brain. In the June 12th edition of Neurone, Brian Knutson of Stanford University describes a brain-scanning study he carried out recently. The pattern and location of the activity he observed suggests the endowment effect works by enhancing the salience of possible loss. But that still does not explain why this sense of loss should be felt. The question is whether such behaviour is truly irrational, or just “differently” rational. That might be the case if, for instance, it was a hangover from the evolutionary past that worked then, but is no longer appropriate now.
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Mug’s game
The endowment effect has nothing to do with wealth (it is not as if chocolate bars and coffee mugs matter) or transaction costs (in most experiments these are zero). Not even emotional attachment, whatever that means, can really be called in as an explanation, since the effect is both instantaneous and sometimes felt even by those who buy and sell for a living. According to Pete Lunn, an economist at the Economic and Social Research Institute in Dublin, professional market traders are often reluctant to sell investments they already hold, even though they could trade them for assets they would prefer to invest in if starting from scratch.
The endowment effect has nothing to do with wealth (it is not as if chocolate bars and coffee mugs matter) or transaction costs (in most experiments these are zero). Not even emotional attachment, whatever that means, can really be called in as an explanation, since the effect is both instantaneous and sometimes felt even by those who buy and sell for a living. According to Pete Lunn, an economist at the Economic and Social Research Institute in Dublin, professional market traders are often reluctant to sell investments they already hold, even though they could trade them for assets they would prefer to invest in if starting from scratch.
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Keep on trucking
Because the endowment effect touches on so many areas, Dr Jones thinks it may be helpful for legislators to understand its evolutionary origins. That goods and rights such as pollution permits, radio spectrum and mobile-telephone licences do not inexorably flow towards the most efficient distribution worries the legal scholars charged with designing fair allocations. The effect also complicates the negotiation of contracts, as people demand more to give up standard provisions than they would have been willing to pay had they bargained anew.
Because the endowment effect touches on so many areas, Dr Jones thinks it may be helpful for legislators to understand its evolutionary origins. That goods and rights such as pollution permits, radio spectrum and mobile-telephone licences do not inexorably flow towards the most efficient distribution worries the legal scholars charged with designing fair allocations. The effect also complicates the negotiation of contracts, as people demand more to give up standard provisions than they would have been willing to pay had they bargained anew.
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Nor is the endowment effect alone in suggesting that Homo economicus is a rarer species than neoclassical taxonomists would like to believe. Other “irrational” phenomena include confirmation bias (searching for or interpreting information in a way that confirms one’s preconceptions), the bandwagon effect (doing things because others do them) and framing problems (when the conclusion reached depends on the way the data are presented). All in all, the rational conclusion is that humans are irrational animals.
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Related books:
-
Nudge: Improving Decisions About Health, Wealth, and Happiness
-
Predictably Irrational: The Hidden Forces That Shape Our Decisions (Also available in an AUDIO BOOK)
- Links
Jeremy Grantham's Favorite Book (LINK) Related book: The End of Normal: The Great Crisis and the Future of GrowthDeal Tips From Buffett and Berkshire’s Other Managers (LINK) Related book: Berkshire Beyond Buffett: The Enduring Value of...
- Bridgewater On The Fed's Dilemma
Via Zero Hedge: In the old days central banks moved interest rates to run monetary policy. By watching the flows, we could see how lowering interest rates stimulated the economy by 1) reducing debt service burdens which improved cash flows and spending,...
- Why Placebos Work Wonders
Found via @farnamstreet. Say "placebo effect" and most people think of the boost they may get from a sugar pill simply because they believe it will work. But more and more research suggests there is more than a fleeting boost to be gained from placebos....
- Comparing Wealth Effects: The Stock Market Versus The Housing Market - By Karl E. Case, John M. Quigley, And Robert J. Shiller (2005)
ConclusionThe importance of housing market wealth and financial wealth in affecting consumption is an empirical matter. We have examined this wealth effect with two panels of cross-sectional time-series data that are more comprehensive than any applied...
- Resisting Influence - Philip Zimbardo And Cindy X. Wang
In The Lucifer Effect, we examined how social situations lead ordinary people to commit unimaginable acts of violence, discrimination, and indifference to the suffering of others. Many of us hope that if we were placed in such situations, we would be...